Governors Making Pension Cuts May Be Thwarted by Employee Suits

New Jersey Governor Chris Christie said he doesn’t mind breaking promises to pensioners to close a $10.5 billion budget deficit -- even if they sue.

“I have bigger issues than who sues me,” said Christie, 48, a Republican and former federal prosecutor who wants to end cost-of-living increases for retirees. “Get in line.”

Public workers in Colorado, South Dakota and Minnesota are already suing their states, which are among 18 that want to pare pension costs by increasing employee contributions, raising the retirement age or curbing cost-of-living increases.

“We believe it’s unconstitutional,” said Gary Justus, 63, a retired mathematics teacher in the Denver public schools who’s a plaintiff in the Colorado suit. “These are contracts that I and 100,000 other retirees worked for.”

U.S. cities, counties and states face a $3.6 trillion gap between their pension assets and what they’ve promised retirees, according to a study by Robert Novy-Marx of the University of Rochester and Joshua Rauh at Northwestern University. States must also contend with $140 billion of budget deficits next fiscal year, according to the Center on Budget and Policy Priorities, a Washington research group.

Pressured to cut spending and not raise taxes, public officials are focusing on pensions, said Ron Snell, senior fellow at the National Conference of State Legislatures. State plans cover 24 million active and retired workers, according to the Denver-based organization, about 8 percent of the U.S. population of 309 million in 2010.

Christie, saying New Jersey’s retirement benefits are “wildly out of proportion with the private sector,” proposed eliminating automatic cost-of-living increases last year. The state has also stopped paying into its pensions.

Borrowing for Pensions

Illinois lawmakers lowered retirement benefits for new workers last year. The state will borrow $3.7 billion this month for its fiscal 2011 contribution, the second consecutive year it sold bonds to make payments.

States have exhausted “more palatable” actions such as cutting staff and expenses, Fitch Ratings said Jan. 25 in a report giving a negative outlook to the state-debt sector. They face the “most difficult” fiscal year since the U.S. recession began in December 2007, Fitch said, as federal stimulus payments end.

The strain of funding pensions intensified as securities markets fell during the 18-month economic contraction, the longest since the 43-month slump of the Great Depression, according to the National Bureau of Economic Research. Asset values fell to about 76 percent of obligations in 2009 from about 82 percent in fiscal 2008, according to data compiled by Bloomberg.

Least-Sound System

Illinois has the least-sound system, with a funded ratio of about 51 percent, followed by Oklahoma and Kentucky, according to the Bloomberg data. Missouri, Oregon and Arkansas are in the middle with about 80 percent, a ratio considered adequate by actuaries.

The “rapid” growth of unfunded obligations prompted Moody’s Investors Service to issue a combined measurement of states’ debt and pension liabilities for the first time on Jan. 27 so investors can compare them with companies. Pressure to fund retirements will continue to have a “negative impact” on state credit ratings, Moody’s said.

Former U.S. House Speaker Newt Gingrich, a Republican and potential 2012 presidential candidate, has proposed allowing states to restructure debts in bankruptcy-like proceedings giving them more leverage in bargaining with employees over wages and pensions.

More than 20 states considered changes to pension plans last year, according to the National Conference of State Legislatures.

‘Serious’ Proposals

“Too many proposals to count” have been introduced so far in 2011, said Snell, the National Conference of State Legislatures’ pension expert. Lawmakers in at least a dozen states, including California, New York and Ohio, have “serious” proposals, he said.

Florida Republican Governor Rick Scott said yesterday that state employees should contribute to their pensions and New Jersey Senate President Stephen Sweeney, a Democrat, said on Jan. 31 that he’ll introduce legislation that goes beyond Governor Christie’s in trimming benefits.

“We’re looking at a year of trying to make widespread and significant changes,” said Snell. “Some of these can provide real savings, if they can be done.”

Some states may switch from plans that provide specific benefits to so-called defined-contribution systems, which are like 401(k) plans used at companies. Three states -- Alaska, Nebraska and Michigan -- have required them, and Utah will beginning July 1. Six make them optional.

Short of Funds

New Jersey’s Christie said in an interview that taking away cost-of-living increases for retirees would break a promise. It’s necessary, he said, because the state’s pension system is $46 billion short of funds.

“There is no alternative,” he said at Bloomberg’s New York headquarters on Jan. 25. Previous officials “knew when they promised it they couldn’t afford it.”

Christie’s statements don’t sit well with Steve Baker, a spokesman for the New Jersey Education Association, whose 200,000 members are covered by the state pension. He said the state failed to make annual contributions to its pension funds in 13 of the past 17 years, including two under the current governor.

“All his tough-guy, let-them-sue-me rhetoric fails to solve the problem,” said Baker. “Until the governor wants to sit down with all the parties and come up with a solution that solves the problem, the governor isn’t doing his job.”

The lawsuits filed in Colorado, Minnesota and South Dakota challenge changes in cost-of-living adjustments, according to court documents.

Purchasing Power

Colorado eliminated annual increases of at least 3 percent, according to court records. Justus, the retired Denver teacher, said losing the adjustments would erode his purchasing power by 35 percent over 30 years. He estimates it would cost all Colorado workers in the plan $40 billion.

“What allows the state to abrogate that contract?” said Justus, who lives in Evergreen, Colorado. “If it’s allowed to stand, it will set an incredible precedent for the state to cut benefits again.”

Colorado’s cuts, which included higher participant contributions and an increased retirement age, were in the public interest after investment losses in 2008, said Gregory Smith, general counsel for the Public Employees’ Retirement Association, known as PERA.

Immediate Reduction

“The legislation was passed to keep the fund from running out of money,” Smith said in via telephone. “We had to reduce the payouts by the fund immediately.”

None of the three lawsuits has been ruled on and there is little precedent for some of the proposed pension changes, said Amy Monahan, a professor at the University of Minnesota Law School in Minneapolis, who studies the legality of changing pension benefits.

“A lot of states are flying blind because there aren’t a lot of cases,” said Monahan. “There is so much legal uncertainty about what is permitted.”

California and Illinois have constitutions that make it difficult to change benefits, said Monahan. Others, such as Maine and Connecticut, have fewer legal constraints, she said.

Property Right

Courts have found that pensions are a property right, said Stephen Pincus, an attorney with Stember Feinstein Doyle & Payne in Pittsburgh, who brought the three lawsuits. The key to whether existing benefits can be cut will be language that determines if a pension is a legal contract and when the agreement becomes property, he said.

A state may be able to change the law if there is a “real substantial likelihood the government cutting is on the edge of financial ruin,” according to Pincus.

“The state has the power to protect its citizens,” said Monahan. “If your fiscal situation looks dire, you could do it to stay solvent.”

States shouldn’t be allowed to make pension cuts a priority over other liabilities, said Pincus.

“It’s our position that a state can’t pick and choose obligations it doesn’t want to pay,” said Pincus. “Are you going to creditors and saying you can’t pay your 30-year bonds?”

New Jersey Governor Chris Christie said he doesn t mind breaking promises to pensioners to close a $10.5 billion budget deficit -- even if they sue. I have bigger issues than who sues me, said Christie, 48, a Republican and former federal prosecutor who wants to end...